Sunday, December 05, 2010

The Miracle Is Over in South Korea. Now What?

South Korea boomed by turning a rural economy into an industrial power. To keep growing, it's going to have to make some fundamental—and difficult—changes

By EVAN RAMSTAD

As it welcomes the leaders of the 20 richest nations this week, South Korea is coming to grips with an uncomfortable truth: The stunningly successful economic strategy that put it in position to host such a meeting is nearing the end of its useful life. And replacing it won't be easy.

Fifty years ago, seemingly trapped in poverty and hunger, South Korea began a rapid rise into affluence while also staring down its neighbor, North Korea, which had invaded it just 10 years earlier and continues to threaten it today. South Korea is now the 15th-biggest economy in the world, home of globally recognized companies like Samsung and Hyundai and a model for developing nations.

But the economic strategy that worked so well for so long has run its course. South Korea has essentially reached the level of wealth that it can attain by relying on exports to turn a rural economy into an industrial one. More of its economic output—43%—comes from exporting goods than in any other advanced nation.

"The country is at an inflection point," South Korean Finance Minister Yoon Jeung-hyun said in a speech in July. "Apparently, there is a limit for export industries to create new jobs and added value."

The question South Korea faces now is both simple and difficult: Can it make the necessary changes—economic, political and cultural—that will let it continue its upward path?

To keep growing, economists here and abroad believe, the country will have to make fundamental changes to its hierarchical, male-dominated society—not only bringing more women into the workplace, but also encouraging innovation and entrepreneurship, promoting by merit rather than seniority and opening the door to immigrants.

It will have to reduce the government's pervasive involvement in the economy, a vestige of a time when powerful presidents and cabinet ministers made hard choices about what to do with scarce capital. And it will have to loosen the country's adherence to Confucian-based hierarchies, following the path taken by such neighbors as Japan, China, Hong Kong and Singapore.

In an interview on Friday, South Korean President Lee Myung-bak described the situation in broad terms. "There is a lot of work to do in reforming many of the social institutions or the norms and the practices and traditions we've had in this country for many, many years," Mr. Lee said. "Some of them have been an obstacle to us becoming a more advanced country. There is a need now for us to try to change."

How South Korea confronts its challenges will be watched by dozens of poorer countries that have emulated the country's successful export-led development model, and by middle-income countries, including Taiwan, Saudi Arabia, Israel and Portugal, which are also hitting plateaus in growth and future potential.

Rise and StallSouth Korea's fast rise began in the 1960s under military dictator Park Chung-hee, who directed scarce capital and resources into many of the same industries that made Japan a powerhouse—textiles, steel, autos and electronics. South Koreans rebelled against authoritarian rule in the 1980s and established a constitutional democracy in 1987, but the economy continued to grow rapidly.

South Korea's per-capita income reached $20,000 in 2007, and while the Asian financial crisis in 1997 and 1998 dealt a blow to the country's traditions of lifetime employment and forced its companies to focus more on profits than growth for growth's sake, the disruption to the country's upward trajectory was brief.

Under the surface of that rising prosperity, however, the seeds of trouble were starting to grow.

South Korea's economic growth averaged 4.3% a year over the past decade, down from 6.2% in the 1990s. The country this year will grow around 6%, better than most advanced countries, but that's coming after two years of marginal performance. Economists' forecasts for next year range from 3% to 4.5%.

What's more, the country's growth potential has dropped further in the past 15 years than any other developed country, according to the South Korea Chamber of Commerce and Industry. Its recent study showed South Korea's growth potential—the maximum possible output when all production factors like labor and capital are used—is now about 4% annually and will likely shrink to between 2% and 3% in the next 10 years.

All this is happening in South Korea at a much lower income level than when it happened in Japan, whose development model, laws and culture South Korea mirrors to a great degree. In the late 1980s, when Japan's growth potential fell to 3% to 4%, its per-capita income exceeded $30,000. South Korea's now hovers around $20,000.

Fewer People, More SkillsPart of the reason for the economic stall is demographic: The country simply doesn't have enough people to drive into jobs to fuel growth. At just 1.15 babies per woman, South Korea's birthrate is the lowest of all developed countries. The number of people in the 25-49 age group has already peaked, and around 2017 to 2019 the overall working-age population will begin to contract.

In addition, South Koreans have reached a point where so many people have become educated that fewer apply for lower-paid, lower-skilled jobs. That's left the nation's farms and manufacturers scrambling for labor, at the same time many college graduates spend their 20s waiting for opportunities in large companies and the government.

Park Ju-eun, a student at Hongik University in Seoul, decided to delay graduation for a year after encountering a difficult job market. "These days, no one graduates as scheduled," she says. "Students put off graduation to have a better chance to get hired."

Ms. Park, who is 24 years old and a management major, applied for jobs at 15 companies, but she wasn't invited to interview at any. She'll get her degree next year and, if she still can't get a job, will study foreign languages and take certification tests to build up her credentials.

The model now for South Korea, economists say, should be countries in Europe and North America that developed robust service industries, which absorb highly skilled workers and complement existing manufacturing competence, and embrace more diverse working environments that stimulate invention and creativity.

To get there, South Korea will need to reshape its economy to be driven from the bottom up, rather than the top down, and confront the cultural traditions that are creating work barriers for women and immigrants.

"Korea has to decide whether it will reconstitute itself and stay in the limelight or get ready for a Japan-style sunset," says Jasper Kim, a law professor at Ewha University in Seoul.

A Heavy HandNo. 1 on the government's to-do list: Stop micromanaging the economy. Such involvement made sense in a country rising from nothing with limited capital and a low level of education. But South Korea is no longer such a place, and the government's hand is widely seen as stifling competition and growth.

Regulations, for instance, say that a company that brews beer in South Korea must be able to produce at least 3.8 million bottles a year, preventing start-up companies from trying to take on the country's two established beer makers. In another area, after an outcry last year over the salaries paid to workers at Korea's privately owned stock exchange, the government took it over and slashed pay.

Government officials acknowledge the problem. But they haven't been able to fix it.

In 2007, South Korea's president, Mr. Lee, campaigned on a promise of economic growth he pitched as the "747" plan—7% annual growth, $40,000 per capita income and the world's seventh-largest economy by 2018. A key element: government downsizing.

Mr. Lee initially set out to privatize about 40 of the country's 400 or so government corporations in hopes of spurring profit-motivated work. By early this year, officials had moved on just one sale—a minority stake in the company that runs the international airport in suburban Seoul. Then, in September, they even stopped that sale in response to political critics.

A similar resistance has arisen when it comes to the government's monopoly of the rates and sale of television advertising. Two years ago, the nation's constitutional court ordered an end to that control, saying it was an illegal monopoly.

The result was that even more government agencies jumped in, wanting to sell advertising or have the power to decide who will. Meanwhile, with government-set TV rates acting as a ceiling to most other advertising, South Korea's media industry accounts for less than 1% of gross domestic product, compared with more than 2% in Japan and 3% in the U.S.

Most visibly, capital-intensive construction projects remain a major tool of influence for South Korea's political leaders, a force that sways both the costs of private development and the land available for projects. Mr. Lee's own megaproject is a $14 billion dredging of four rivers.

This summer, Mr. Lee and his deputies tried to change plans for a $20 billion city that lawmakers had designated as a new home for half of the national government, arguing that the project should be driven by the needs of the private sector. But he lost the battle in parliament. Mr. Lee's second-in-command, Prime Minister Chung Un-chan, an economist who questioned the viability of a government-centric city, resigned over the matter in July. "I felt guilty for failing to prevent the expected waste," he said.

Part of the reason the government's heavy-handed role in the economy is accepted is because it's in line with Korean society's Confucian-rooted belief in the power of hierarchies. That same belief spills over to everyday work. South Koreans routinely defer to people older than themselves, a habit that preserves order but chills interaction and suppresses new ideas.

And the hierarchical tradition is further complicated by the power it assigns to men over women. Until the 1990s, Korean textbooks preached that women should stay at home. Even now, women are routinely encouraged to quit work when they become pregnant. And it was only this April that a judge for the first time held a South Korean company liable in a sexual-harassment case involving a male boss and female subordinate.

Today, only 53% of Korean women work, below the 57% average of all developed countries, a problem that will loom even larger when the labor force starts to contract later in the decade. The average salary for a South Korean woman is about $16,931, just over half the $32,668 average for men, the biggest wage gap among developed countries.

And for the women who do work, opportunities for advancement are stifled by the outsize role that a late-night, male-centric drinking culture plays in business life. In its most extreme form, after-hours socializing takes place in so-called room salons where young female hostesses pour drinks and converse with groups of men, an atmosphere that excludes their female colleagues from opportunities for business deals and networking.

The Unwelcome MatThe fastest spur to growth would be to welcome more foreign workers and immigrants to the country. South Korea has 557,000 foreign workers, about 2% of its work force of 23 million. That's higher than in Japan, where the number is less than 1%, but well below the 10% of the U.S.

But foreigners can stay only five years at Korean-owned companies, according to work laws. Permanent immigration is extremely rare, though it has grown in recent years for a special category of immigrant: women from other countries, mainly in southeast Asia, who marry the single farmers left in rural areas after young Korean women moved to cities.

Min San-gi, who owns a car-parts company in the city of Suwon, is limited to just 10 foreigners in his factory of approximately 50. His foreign workers will stay the five years with him, but his Korean workers tend to go quickly, sometimes after just a few months or a year. Despite relatively low pay, Mr. Min treats his foreign workers well, and even won an award from a Catholic charity group for his work with immigrants.

Meanwhile, as with other small employers, Mr. Min's company experiences a high turnover rate among his Korean workers who, as part of a dwindling pool willing to do factory work, are seeing more opportunities.

As a result, Mr. Min has essentially allowed his company's growth to be centered elsewhere: Three years ago, he opened a larger factory in Vietnam, where he's had no problems finding a stable work force. "I feel it's a kind of shame to have left Korea," he says.

What It Will TakeConfronting the problems today is more difficult than mustering the will to rise up from poverty was in the 1960s, says Huh Chan-guk, an economics professor at Chungnam University in Daejeon. "We don't have that consistent meeting of the minds with staying power compared to the magnitude of the problems," Dr. Huh says.

For economists specializing in South Korea, the country's growth dilemma has become grist for theorizing; several investment banks recently issued formulas for jump-starting its medium-term and long-term growth.

A study by Danny Leipziger, a professor at George Washington University and a former World Bank vice president, showed that, with enough productivity improvements and greater employment of women and the elderly, South Korea could reach even the 7% growth target Mr. Lee touted in his presidential campaign.